Question 5 (3 marks)

Suppose that United Airlines and American Airlines are the only air carriers that serve between New York and Boston. Each currently earns a profit of $6,000 per flight on this route. If United increases its advertising spending in this market by $1,000 per flight, and American spends no more on advertising than it does now, United's profit will rise to $8,000 per flight and American's will fall to $2,000. If both spend $1,000 more on advertising, each will earn an economic profit of $5,500 per flight. These payoffs are symmetric, so that if United spends the same amount on advertising while American increases its spending by $1,000, United's economic profit will fall to $2,000 per flight and American's will rise to $8,000.

American's Choices Raising Spending Leave spending as same Raising $5500 for United $8000 for United United Spending $5500 for American $2000 for American Choice Leave spending $2000 for United $6000 for United as same $8000 for American $6000 for American